Workers Lose Billions Of Dollars In Flexible Spending Accounts

Taxpayers lose quite a bit of money in flexible spending accounts (FSAs) each year while trying to save a few tax dollars.

FSAs are fairly simple. Before the start of the year, an employee elects to defer part of his or her compensation into an FSA. The deferred amount is excluded from gross income for the year, avoiding income taxes.

During the year the employee can be reimbursed from the FSA for qualified medical expenses. The employee has to submit receipts and complete a reimbursement form. The reimbursements are tax free, so using an FSA allows an employee to convert some salary into tax-free income.

But if the employee’s expenditures aren’t qualified medical expenses, the FSA can’t reimburse them. If the employee’s qualified medical expenses for the year don’t at least equal the amount deferred into the FSA, the balance left in the account reverts to the employer.

The employer can adopt one of two provisions that can help the employee avoid forfeiting FSA funds. The employee can allow the employee a grace period during which the leftover balance can be used to reimburse some medical expenses incurred early the next year. Or an employee can be allowed to carry over part of the unused balance to the next year.

Under the grace period, qualified medical expenses incurred between January 1 and March 15 the following year can be reimbursed from the previous year’s FSA contributions until the balance is exhausted.

The alternative is to allow the employee to carry over up to $500 of the FSA balance to the next year. The carry over limit is indexed for inflation annually and is $610 for 2023.

But the employer doesn’t have to allow these options, and it can allow only one. Even when one of the exceptions is in place, employees still can lose significant FSA balances because of the limits of the exceptions.

The government doesn’t compile much data on FSAs and how much money is forfeited to employers.

The Employee Benefit Research Institute (EBRI) says it has been able to obtain a lot of data on FSAs.

EBRI found that in 2019, 44% of workers with FSAs forfeited at least some of their money. On average, the workers lost $339. In 2020, 48% of workers forfeited some money, with the average forfeit being $408.

Money.com did the arithmetic using an estimate of the number of FSAs in existence and concluded workers in aggregate forfeited $3 billion in 2019 and $4.2 billion in 2020.

Employees can avoid losing money in FSAs.

Before deciding how much salary to defer to an FSA, make a reasonable estimate of the qualified medical expenses you might incur next year, assuming it’s a normal year. Don’t automatically defer the maximum amount the tax code allows.

Throughout the year, monitor the balance in the FSA and the amount that’s going to be deferred into the account the rest of the year. Be sure you’re on track to use the account balance on qualified medical expenses.

Of course, obtain and save receipts of all medical expenses that qualify for reimbursement from the FSA. Then, submit timely claims for reimbursement in whatever form the plan requires. As you enter the last quarter of the year, project the December 31 FSA balance and establish a plan to spend the balance by the end of the year. Key actions can be to schedule elective medical treatment and purchase new eyewear.